November 2012

A PUBLICATION OF CHILTON CAPITAL MANAGEMENT

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union workers. While the world rebuilt following World War II, US labor remained protected. But Samuel Rines when the world eventually restarted its factories, Japan, quickly followed by China (spurred by Japanese investment), found a competitive advantage in manufacturing. Once protected by the lack of international competition, US workers omewhere in the depths of a slightly idealcame under pressure from lower wages overseas, ized history, the US believed itself a nation cheaper imports, and foreign economies that of builders. And this is a good thing to protected their infant industries. Then, as now, be. Manufacturing and its spillover effects blame China. Using China as a scapegoat is an play a vital role in the health of the economy. easy and politically acceptable method of explainManufacturers provide well paying jobs for working away the issue, but it dodges the critical eleers who would otherwise earn low wages, and they ments of which jobs stayed, which left, and where tend to export more than their service producing they went. counterpartsa critical component of avoiding a Undoubtedly, many of the jobs moved overseas, greater trade deficit. But, slowly, manufacturing but outsourcing to foreign nations is not the only has become less and less a part of the US economy. mechanism at work in the changing dynamics of Manufacturing employment peaked in 1979, and US manufacturing. Today, only 9 percent of all as a percent of total employment has been in US jobs are in manufacturing, and employment is steady decline since the 1940s, even as productivat its lowest level since the 1940s. The Northeast, ity skyrocketed and the value of manufactured Mid-Atlantic, and Rust Belt have seen employgoods continued to increase. Some US jobs moved ers move to the South and West in search of US to the Southern US, and highly skilled jobs have talent at cheaper prices. This has been happenbeen created while lower and middle skilled jobs ing since the turn of the century, but the trend disappeared. Simply, US manufacturing has been accelerated in the latter half of the 20th Century. declining, changing location, and outsourcing And the period between 1990 and mid-2011 was in an attempt to remain competitive with less the real game changer. All the Federal Reserve expensive labor, and to match skills with other Districts lost manufacturing employment durdeveloped nations. ing this time, but the East Coast was particularly hard hit. While New York, Boston, Philadelphia, The Context and Richmond lost more than 40 percent of their And this has been happening for a long time. The manufacturing employment, the West fared much Wagner Act of 1935 allowed workers to bargain better with Minneapolis, Dallas, and Kansas for higher wages and safer working conditions. But City dropping less than 15 percent. There is a the Unions distorted the labor market, especially significant amount of trepidation about Chinese in manufacturing, leading to job losses for nontrade practices and the size of the US trade defi-

Against the World

cit. However, instances of re-shoringbringing previously outsourced jobs back to the USare happening at an increasing clip as US companies begin to factor in economic costs they had previously underestimated, such as threats to IP integrity and logistical nightmares. Grow What You Can Keep US Manufacturing is exceedingly regionalized with specialties differing across geographies. However, the common theme of all sectors is that the US tends to keep jobs in industries making goods that are cheap relative to their weight, or that pay high wages. This is not inherently due to the level of the wagesbut because those jobs tend to be knowledge intensive. They also tend to be jobs with the most innovation feedback for the economy, which makes them some of the most valuable.

The US tends to keep jobs in industries making goods that are cheap relative to their weight, or that pay high wages.
Company level research and development and employee training are pivotal factors in creating and sustaining innovative firms. R&D can create new products and innovations, and training and continuing education allow workers to maintain pace in a rapidly changing work environment. The problem is that it is impossible for firms to prevent these benefits from spilling-over to those who did not pay for them (free-riders). And it is a big problem. In a competitive world, it is no small part of the reason firms are somewhat hesitant to invest heavily in R&D. In 2000 US R&D dominated the rest of the world, accounting for more than 61 percent of worldwide spending. By 2009, this figure had declined to 45 percent and has continued to fall. It is critical to continue to lead in innovative industries and manufacturing, but it also takes investment of both time and money.

ble. Interestingly, manufacturing wages are higher than the service sector counterparts making manufacturing jobs attractive. So, why has a US wage advantage not driven a boom in manufacturing? By some measurements, there are more job openings now than there were in the pre-crisis boomover 4.5 million of them posted online, more than the pre-recession peak. But, if this is true, why is the unemployment rate in the US so high? There are two primary reasons. First, the implosion of the housing bubble made it more difficult for workers to relocate to areas where jobs are available. Selling a home for a loss is a deterrent to moving regardless of the employment possibilities. Second, and more significantly, there is a glaring skills gap. The skills of those searching for employment do not match available jobs. In fact, the skills gap could account for more than 1.5 percent of the current unemployment rate. Workers can be incentivized to move with tax breaks for employers and the potential employee, and moving does not take much time to accomplish. Skills do take time to develop, often require additional schooling, and are expensive to obtain.

Skills, Skills, Skills U.S. manufacturing is making a sort of comeback, especially highly skilled, technology intensive manufacturing, but the new manufacturing requires technological know-how and computer skills that were previously unnecessary. It is old economy manufacturing in name only. Since about half the employment lost during the great recession was in construction and manufacturing, there is every chance these workers will need new skills to find new employment. But it takes time and resources. The issue, then, is retraining an existing workforce for a new economy. And the incentives for doing so transcend the well-being of the workers themselves: As workers retrain and find employment, they spend more in their local communities. Thus, communities and local business feel confident enough to increase their Jobs, Jobs, Jobs employment, and so on. Believe it or not, the US actually does have a But many workers who could benefit the most few advantages when it comes to manufacturing, from retraining are unable to afford it or have an especially in comparison to many of its European understandable aversion to taking on new debts. counterparts. Notably, the US has relatively low Others do not have accurate information on how wages in manufacturing for a developed nation. much retraining can actually put in their pocket. The US is not quite the developed worlds China And the returns can be substantial, especially that honor goes to Spain or Greecebut it is for those workers who train for more knowledgesignificantly cheaper than many of the Northern intensive industries and who are relatively young European stalwarts. In 2011 for example, average with a long career ahead of them to realize the wages in Germany were 39 percent higher than in gains. These hurdles are not easily overcome. the US. In Denmark, they were nearly 48 percent Recessions are when people should demand the higher. So, when compared to our developed com- most retraining, but they are also when State petitors wages in the US are more than reasonaand local governments are making cuts to com2

munity and technical college budgets. Budgets need to be boosted at the very time that tax receipts are declining. It can be done, though at significant costs. The Nordic states, scorned for their particular version of capitalism, are leaders in retraining their populations when the tide has turned against them. The Danes may be the best at understanding the necessity of retraining a workforce. In the event of unemployment, the Danish buoy wages to make retraining feel attainable. And the training extends to apprenticeships and even college. They incentivize workers to continue their education, retrain, and take professional career paths. This comes at a significant cost to Danish taxpayers: between 4 and 5 percent of GDP is dedicated to ongoing labor initiatives. The U.S., for better or worse, does not spend anywhere near that much. The Danish model may not be palatable in the US, but understanding the policy is essential to comprehending the competitive nature of manufacturing in the world today. If the Danes are the model for retraining and redeploying educated workers in the short-run, the Germans are the long-term model. The Germans combine apprenticeships and schooling to form their dual system creating job specific skills that can be carried from one company to the next. Essentially, the Germans have created a system of on-the-job training that rewards both employees and employers. Employees get a certificate that is recognized by other firms, and businesses get a technically and academically educated worker. To incentivize technical education, workers are paid during apprenticeships, and have a known job at the completion of the program. For the Germans, the benefits of a technically sound, motivated, and loyal employee base are far too enticing for businesses to pass on (not to mention the appeal of a paid apprenticeship and certification for the potential employee). The risk of losing a trained employee is mitigated by the corporate resources and number of trainees being trained with similar skill-sets. This system creates a dynamic and capable workforce with skills applicable to the manufacturing jobs that are available, and continuing education policies encourage workers to maintain and update their skills. Against the World The competition is not simply China. US manufacturing is competing with highly skilled and educated European labor and low cost Chinese labor. The Nordic states maintain their competitive edge by subsidizing, retraining, and skill attainment. Apprenticeships in Germany, and the technical prowess they instill, create an environ3

The competition is not simply China. US manufacturing is competing with highly skilled and educated European labor and low cost Chinese labor.
ment in which manufacturing can thrivethere is a reason German engineering is an advertising byword. Even with these disadvantages, there are reasons for optimism in the US: There are jobs available, the US is increasingly cost advantaged compared to the rest of the developed world, and the housing market is stabilizing (allowing for a more mobile workforce). But it is not all positive. Others are catching up to the US in R&D investment, and it is likely that when the National Science Foundation releases its next report the US will be behind Asia. China undoubtedly will edge closer to the US. Manufacturing has a glorified past in the US. It remains a critical part of the US economy, adding more than $1.7 trillion in value, and there is a chance it has a bright and prominent future in the US economy. But the US must realize what it is competing for, and against, in a world fighting for jobs.
Sources: Bureau of Labor Statistics data, International Comparisons of Hourly Compensation Costs in Manufacturing and Employment Situation Reports. Deitz and Orr, A Leaner, More Skilled U.S. Manufacturing Workforce. Helper, Krueger, and Wail, Locating American Manufacturing: Trends in the Geography of Production. Helper, Krueger, Wial, Why Does Manufacturing Matter? Which Manufacturing Matters? A Policy Framework. Wilkerson and Williams, The Transformation of Manufacturing Across Federal Reserve Districts: Success for the Great Plains?. National Science Foundation, Science and Engineering Indicators 2012. Schuh and Triest, The Evolution of Regional Manufacturing Employment: Gross Job Flows within and between Firms and Industries. Conference Board, Help Wanted OnLine (HWOL).

SAMUEL RINES is an a nalyst and Economist at chilton capital m anagEmEnt in houston, tExas. dirEct quEstions or commEnts to: srinEs @chiltoncapital .com ZACH BECK is thE E ditor of chilton currEnts and an opErations spEcialist at chilton capital m anagEmEnt in houston, tExas. for furthEr information on chilton capital m anagEmEnt stratEgiEs and sErvicEs, plEasE contact christophEr l. K napp, cKnapp@chiltoncapital .com for rEprints contact srinEs@chiltoncapital .com www.chiltoncapital .com/currEnts